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August 31, 2012

Fed’s Bernanke Makes Case for QE3

The Federal Reserve is getting ready to take more action, Chairman Ben Bernanke suggested Friday at Jackson Hole, as he pointed to the Fed’s success in using non-traditional methods to keep the struggling U.S. economy out of a double-dip recession.

In Bernanke’s speech before the Federal Reserve Bank of Kansas City Economic Symposium in Jackson Hole, Wyo., the Fed chairman outlined the challenges of using nontraditional tools such as “forward guidance” communication plus the Federal Open Market Committee’s (FOMC) quantitative easing and Operation Twist securities-buying programs.

He concluded that such nontraditional tools in a historically low-interest-rate environment had worked to bring the U.S. out of recession and that they will continue to work to keep the economy in recovery.

“It seems clear, based on this experience, that such [nontraditional] policies can be effective, and that, in their absence, the 2007-09 recession would have been deeper and the current recovery would have been slower than has actually occurred,” Bernanke said. “The Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”

LPL Financial investment strategist John Canally said Bernanke spent a lot of time talking about the cost of quantitative easing, but that he also seemed very concerned about the state of the economy and that the Fed can manage the cost of a third round of quantitative easing, also known as QE3.

“It’s still a matter of when and how, not if the Fed is going to act,” Canally said an hour after Bernanke’s 10 a.m. eastern time speech. “He didn’t talk about the ‘how’ much, whether the Fed will do quantitative easing in chunks or in a more open-ended way. He sounded a little more concerned about the economy than in the past, which might tilt the Fed to Sept. 13, but I don’t think there’s any question that they’re getting ready to act.”

Stocks Sell Off but Recover Quickly

The U.S. stock markets sold off in reaction to Bernanke’s speech, which Canally characterized as “a naïve, knee-jerk reaction” to what the Fed chairman said.

“He’s never going to say, ‘Oh, we’re going to start buying bonds today.’ If anyone thought that was going to happen, they weren’t paying attention,” Canally said. “In the first five or 10 minutes after the speech there was a sharp dip in stocks, and now we’re pretty much back at the highs of the day. When people in the markets had a chance to read through the speech, they realized that more Fed action is coming, and it’s just a matter of when and how, not if.”

The U.S. stock markets were up across the board at noon. The Dow Jones industrial average was up 124 points, or 0.96%, at 13,126. The S&P 500 was up 10.50 points, or 0.75%, at 1,410. The Nasdaq index was up 20 points, or 0.66%, at 3,069.

Jim O'Sullivan, chief U.S. economist for High Frequency Economics, also believed that Bernanke’s Jackson Hole speech was clearly consistent with more Fed easing, although not definitive.

“Much of the speech was used to defend the Fed's use of unconventional policies in the current cycle, particularly asset purchases,” O’Sullivan wrote in an analyst note. “The key takeaway of that defense: ‘we should not rule out the further use of such policies if economic conditions warrant.’”

O’Sullivan noted Bernanke’s dissatisfaction with the disappointing recovery, and said that at a minimum, he expects FOMC officials to extend forward guidance on the near-zero funds rate at the September meeting, “with a slightly better than 50% chance that a new asset purchase program—i.e., QE3—will be announced then as well.”

Bernanke Knocks Congress on Fiscal Cliff

As for Congress’ responsibility in setting a clear course for the U.S. recovery, Bernanke once again stated that the Fed’s monetary policymaking abilities can only take the nation so far in creating jobs.

“Fiscal policy, at both the federal and state and local levels, has become an important headwind for the pace of economic growth. Notwithstanding some recent improvement in tax revenues, state and local governments still face tight budget situations and continue to cut real spending and employment,” Bernanke said. “Uncertainties about fiscal policy, notably about the resolution of the so-called fiscal cliff and the lifting of the debt ceiling, are probably also restraining activity.”

It is critical, he said, that fiscal policymakers create “a credible plan” that sets the federal budget on a sustainable trajectory in the medium and longer runs. “However, policymakers should take care to avoid a sharp near-term fiscal contraction that could endanger the recovery.”

Canally commented that even though Congress is, in essence, Bernanke’s boss, the Fed chairman does not shy away from that policymaking fight, and he didn’t Friday.

“We need an adult in the room, and Bernanke is the adult,” Canally said. “At virtually every single public appearance that Bernanke has made, and especially when he testifies before Congress, he gently reminds Congress that their job is to balance the budget and the Fed’s is to manage monetary policy.”

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